Fed Worries About Rising Prices, Risk In Some Bonds

By Michael Aneiro

Bloomberg is out with a story this morning that looks at some recent Federal Reserve communications and sees the Fed growing concerned about overheated prices for a variety of assets such as risky bonds. Which sounds sort of like an arsonist growing concerned about overheating in the buildings he’s been setting on fire. Such overheating has been fueled primarily by the Fed’s policy of near-zero interest rates and its ongoing bond-buying programs, which have caused yield-starved investors to bid up risky bonds and other assets to record levels. Bloomberg’s Craig Torres reports:

Now, as central bankers boost their stimulus with additional bond purchases, policy makers from Chairman Ben S. Bernanke to Kansas City Fed President Esther George are on the lookout for financial distortions that may reverse abruptly when the Fed stops adding to its portfolio and eventually shrinks it.

“Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels,” George said in a speech last week. “We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances.”

Bernanke himself raised that concern this week, saying the central bank has to “pay very close attention to the costs and the risks” of its policies during a Jan. 14 discussion at theUniversity of Michigan’s Gerald R. Ford School of Public Policy in Ann Arbor.

This is stoking concern about what happens when the Fed decides to put an end to its bond purchases:

The first sign of Fed tightening may set off a hair trigger in thebond market, said Drew Matus, senior U.S. economist at UBS Securities LLC in Stamford, Connecticut.

“There is no pulling back a little,” he said. When the Fed begins to shrink its portfolio, investors will start to price in the entire stock of bonds coming back into the market. “It is always going to be hard to disengage in a very gradual manner.”

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